Legal ruling 382

Application of Corporate Commencing Year Tax as Credit to Tax for Year of Dissolution for Corporations "Doing Business" Prior to Enactment of Original Bank and Corporation Franchise Tax Act and Prior to the 1933 Amendment

Facts

The California franchise tax law was extensively amended in 1971 to change the method of taxing corporations discontinuing business in California. The new system applies generally to corporations which cease doing business, dissolve or withdraw after December 31, 1972. It imposes a tax on the income of the final year, which income was not taxed under the old rules. In conjunction with this change, Section 23201 was added to the code to allow a corporation whose tax for its first taxable year was computed under Sections 23222 to 23224, inclusive (or corresponding sections of prior laws)a credit against the tax for its final year. The credit is to be an amount equal to the tax paid by the corporation for its first taxable year which constituted a full 12 months of doing business  in the state. The corporation must furnish evidence of the tax paid to be entitled to the credit.

The legislative intent in enacting the provisions taxing the income from the final year of operations and permitting a credit for the first year's tax was to have each year's income serve as a measure of tax once, but only once.

The original Bank and Corporation Franchise Tax Act was enacted on  March 1, 1929. The intention of the act was to tax, starting January 1, 1929, the exercise of the corporate franchise by all corporations "doing business" in California. (See California Tax Laws of 1929 by McLaren and Butler.) The tax was to be paid at the end of a corporation's fiscal or calendar year for the privilege of exercising its franchise for the next year. The measure of the tax was the corporation's income for its preceding year. It replaced an old law that assessed a franchise tax based upon the value of the corporate franchise (property tax).

The significant sections of the 1929 act, Sections 4, 11, and 13 are attached. Section 13 of the act provides for the initial commencing corporation tax, and is a predecessor to Section 23222. The tax initially only covered banks and corporations actively "doing business."

Corporations commencing to do business after the effective date of the act, March 1, 1929, were required to pay a minimum tax at the time they started "doing business." At the end of the first period of operation, they were then required to pay a tax for that period of operations based upon the income from that period, and in addition prepay a tax for the next full year of doing business. When the corporation's first year of business was a full year, the tax paid was on an identical basis to the tax paid immediately prior to the 1971 change in the law. However, when the first operating period was less than a year, the income was nevertheless the measure of the tax for the succeeding taxable year of 12 months. Section 13 was amended in 1933, and the change required the first year of doubling up of taxes to be based on a full year of doing business similar to the commencing corporation section prior to the 1971 changes.

A corporation doing business before 1929 on a calendar year basis filed a return on May 15, 1929, and prepaid its tax for 1929 based on its federal net income for 1928. The 1929 income was the basis for the prepayment of tax for 1930. The initial payment of tax in 1929, based on its 1928 income, put the old corporation in a prepaid position. If the 1929 payment is used as a credit under Section 23201, these corporations will still have paid a tax on all income earned during the effective periods of doing business under the act.

A corporation doing business before 1929 on a fiscal year basis also filed a return on May 15, 1929, and prepaid its tax. However, the prepayment was only for the months in 1929 corresponding to the months in 1928 which fell within the fiscal year ended in 1928. The measure of the tax was a portion of the income earned for the fiscal year ended in 1928. If the corporation had been "doing business" for a full year and its fiscal year ended June 30, 1928, one-half of its income would be used as a measure of the tax to be prepaid for the first six months of 1929.

Complications arise as to a corporation which did not do business for a full year prior to filing its first return based on 1928 income on May 15, 1929, and in cases where a corporation's first return was not required to be filed until later in 1929 or in 1930. The most frequent questions expected to arise are as follows.

Question

When, if ever, is a bank or corporation entitled to the credit for the first full year's tax under Section 23201 under the following conditions:

1. If it was in existence and "doing business" during all or part of 1928 and operated on a calendar year basis.
   
   
2. If it was doing business during all of 1928 and filed a fiscal year return in 1928, which was the basis for its first prepayment of franchise tax for part of 1929.
   
   
3. If it was in existence and doing business part of 1928, operated on a fiscal year basis, and filed its first fiscal year tax return in 1929.
   
   
4. If it incorporated either before or during the period January 1, and February 28, 1929, but commenced doing business during that period and operated part of a year or a full year before filing a return.
   
   
5. If it commenced doing business on or after March 1, 1929, its first year was less than 12 months, and it filed its first return before the 1933 amendment to the act was effective.

Decision

1. The corporation is entitled to a credit for the tax paid based upon the return filed on or before May 15, 1929.
   
   
2. The corporation is entitled to a credit for the tax paid based upon the return filed for the fiscal year ended in 1929.
   
   
3. The corporation should not receive any credit for any tax paid.
   
   
4. The corporation should not receive any credit for any tax paid.
   
   
5. The corporation should receive credit for the prepayment for its second year's tax.
   
   

Discussion

1. A calendar year bank or corporation that was doing business in 1928 was required to file its first return on or before May 15, 1929. The net income for 1928 was used as a basis for determination of the tax to be prepaid for the exercise of the corporate franchise for all of 1929 regardless of whether the corporation operated during all or part of 1928. This prepayment was intended to put the old corporations on a prepaid basis similar to new corporations formed after the enactment of the law. Giving the corporation a credit for the tax paid during 1929, based on its 1928 income, will still subject the corporation to a tax on each year of doing business under the Bank and Corporation Franchise Tax Act. The tax paid was based on a section of prior law corresponding to Section 23222. Consequently, these corporations should be given a credit under Section 23201 for the tax paid on its return filed on or before May 15, 1929.
   
   
2. A fiscal year corporation that had been doing business during all of 1928, and filed a federal income tax return in 1928, was required to file a California return not later than May 15, 1929. The return reported the net income for the fiscal year ending in 1928. The tax was determined on only a portion of the income, depending upon the number of months in 1928 included in the fiscal year. If there were six months in 1928 included in the fiscal year, one-half of the income would be used as a basis for the tax. This payment would prepay for the exercise of the corporate franchise for the first six months of 1929. Consequently, the tax on the first return filed was for the prepayment of the franchise tax for only part of 1929. Based on the above, the prepayment of the franchise tax for the first full year of doing business under the act would be the tax based upon the return filed for the fiscal year ending in 1929. This later prepayment should be the basis of the credit. The same reasoning should be applicable to a corporation which only operated part of 1928 but filed a fiscal year return in 1928. The prepayment based on its 1928 fiscal year income will cover all months for the fiscal year ending in 1929. The prepayment of tax based on the fiscal year ending in 1928 is not measured on 12 months of doing business, so the prepayment of tax based on the fiscal year ending in 1929 should be the basis of the credit.
   
   
3. This corporation was required to file a return within two and one-half months after the close of its fiscal year. The tax paid was for the next full year of doing business regardless of how long the corporation had been operating. However, as the corporation did not operate during all of 1928 and did not have a fiscal year ending in 1928, it was not required to pay any franchise tax for the months in 1929 included in the fiscal year period ending in 1929. The original law contemplated the payment of a franchise tax for all corporations doing business for all months in 1929. In this situation, the tax paid or the return filed in 1929 prepaid the tax for the taxable year ending in 1930. If this corporation is given a credit for the prepayment of tax for its first full year of "doing business," it will not have paid any tax for the months in 1929 included in the fiscal year period ending in 1929. The corporation, therefore, should not receive any credit for any taxes paid.
   
   
4. The Jones-Moore Paint House case, Cal. St. Bd. of Equal., February 24, 1931, points out that a corporation that falls into this category was permitted to conduct a full year of business under the act without any payment of taxes for the first year. The first full year of operations was free from tax under the law, as interpreted, so there should be no tax credit for any year's payment for such a corporation.
   
   
5. These short year corporations may include both fiscal and calendar year corporations. The Jones-Moore Paint House case, supra, states clearly that if the corporation were a calendar year corporation and was only "doing business" for one month in 1929, its prepayment of tax for 1930 based upon the 1929 income was for the full year. There seems to be no sound reason to treat fiscal year corporations formed after the effective date of the act any differently. The prepayment of the tax for the first full taxable year should be used as a basis of the credit. After the 1933 amendment was effective, the commencing corporation tax was based on a full twelve months of operations in a manner similar to that under the law prior to the 1971 amendment to the law.